Wesley Chapel, FL

Investors,

Happy New Year!

Around this time last year, we started asking everyone to give us their predictions for where the S&P 500 would finish the year 2021. Well, now we know who was closest. If this was an episode of “The Price is Right,” we would all have been in the game because NOBODY was over!

Literally, not a single person of the 50 client and staff predictions was higher than where the market actually finished. I find that astonishing. It just goes to show you how abnormal the market behaved all year long.

As a group, the average prediction was for the S&P 500 (SPX) to finish at 3,973.56, a gain of 5.8%. Only two people predicted the market would be up more than 20% and seven people predicted the market would be down for the year. The SPX finished the year at 4,765.75, up 26.9% from 3,756.07 at the end of 2020.

The closest guess of all was yours truly. My prediction was 4,633 and the S&P 500 index finished at 4,765.75. I was off by 132.75.

The next closest was Armando A. at 4,600. After that we had Jason B. at 4,396.10, and Olivia came in at 4,356. The third-place client prediction was Angie F. at 4,319.

Armando, Jason and Angie – we will be sending your prizes shortly. We are waiting on them to come in from the vendor. Olivia will get a little something too!

The prizes for this year are YETI® mugs and water bottles. We will contact the winners to arrange delivery.

Thank you all for submitting your predictions. It is a fun way to kick off the year. With that in mind, let’s do it again. Please send your prediction to anyone on the Elevate Team via email, or feel free to use the contact form on our website.

What we need from you is either the value at which you think the SPX will close on 12/30/2022, or the percent change you expect for the index this year (and we can do the math to determine your value from there).

Predictions need to be in by the time I send out my next commentary – likely around the 10th of February.

Moving on…

Many clients and prospects have a misunderstanding of our Income Strategy and wrongly assume that because of its name, it must include a lot of bonds. It really doesn’t. There is currently only one bond position in the strategy, and it is a floating rate ETF. This fund is designed to do well when interest rates rise. Most bonds and bond funds go down when interest rates rise, so this quite the opposite.

The reason we don’t own many bonds is because I think bonds are overpriced, and they have been for a long time. Said another way, I think interest rates are too low, and they have been for a long time. Our Income Strategy has always focused on generating current income for investors, but not necessarily in the form of bond interest. Rather, we have largely focused on generating income through dividends.

Over the years, we have done a good job of this, but the name still doesn’t fit as well as we’d like. So, we are going to change the name of the Income Strategy to the Value Strategy, going forward.

This isn’t going to change much about the construction of the strategy. The one thing it might do is allow for buying some value-oriented stocks that don’t currently pay a dividend. We have historically not done much of that. In fact, the only position that I can recall us ever holding that didn’t pay a dividend is gold. We still hold that position today as a hedge against chaos.

But the strategy is largely a “value” strategy already and so the name is changing to fit the underlying methodology. We may buy more bonds in the strategy someday – but not until they represent what we view as a good “value.”

By the way, despite the stock market going up without ever really pulling back in 2021, bonds were not so lucky. As measured by the Barclays Aggregate Bond Index the bond market was down 1.54% in 2021. Meanwhile, our one bond position (FLOT) was up 0.44%. Not bad.

I think that bonds will continue to struggle in 2022 as the Federal Reserve Bank (the FED) backs away from the table, buying fewer bonds to manipulate interest rates lower, and maybe at some point even letting go of some of the bonds they have bought over the past several rounds of Quantitative Easing. When the biggest buyer in any market walks away from the table, prices tend to decline. I think the same will be true for the bond market, too.

As I mentioned in my last letter, the last time the FED did this (called Quantitative Tightening) was the las time we saw a negative return for the stock market during a calendar year. That was in 2018.

Looking back to the beginning of the century… millennium perhaps? everything after “the 1900’s” as the kids say: The SPX has gained about 7% per year on average, with down years averaging a loss of 15%. If you shorten that time frame to the past 20 years, the average annual return increases to just shy of 9% with the average losing year down more than 17%.

Thankfully, the stock market is usually up. Only 20% of the time over the past 20 years, and 27% of the time since the 1900’s has the market finished a calendar year with a loss. But we haven’t had an “average” drop in a very long time. So, maybe we are due for one in 2022.

JP Morgan Annual Performance and Declines

Looked at another way, thanks to our friends at JP Morgan (JPM is a holding in the Value Strategy) the SPX has dropped 14% on average at some point during every year going back to 1980. Yet, 32 out of 42 (76% of) years have finished with a positive overall return.

Along with the name change for the Value Strategy (FKA Income Strategy) we are going to change the name of the Appreciation Strategy, too. The Appreciation Strategy will be called the Growth Strategy, going forward. The main driver for this is simplicity. Appreciation has too many syllables and is basically just a fancy way of saying “growth.” We aren’t fancy, so growth fits better for us.

We have two primary strategies that we offer and operate. One is called Value and the other is called Growth. Our clients can be fully invested in either one, or we can combine the two strategies in three standard ways. The most common strategy selected by our clients is the 50/50 combination. We also offer 25/75 and 75/25 combinations. The first number in the combinations always refers to the Growth (FKA Appreciation) Strategy.

It is probably also worth recapping at the start of a new year exactly what the goals of each strategy are.

The Growth Strategy is designed to match the stock market (S&P 500) return when the market is going up, but to outperform (lose less) when the market is down.

The Value Strategy is designed to go up about half as much as the stock market (S&P 500) when it goes up, but to lose much less when the market goes down.

We can’t guarantee that will always happen, but in our history of managing these strategies we have had great success, especially on the downside. Our long-term upside has been in alignment with expectations, too.

Performance

December was a wild month for the market. For the first 20 days, the market was down for the month before staging a big recovery over the final 10 days. Our Growth Strategy and Value Strategy flip-flopped roles with the Growth Strategy being up about half as much as the SPX and the Value Strategy being up quite a bit more than the index in the final month of the year.

As it turns out, the Value Strategy ended up beating the Growth Strategy for the year 2021, too. This is not something I would have expected heading into the year. If you told me that the SPX was up more than 20% for the year, I would have definitely guessed that the Growth Strategy would have been the best performing Elevate Strategy.

But it was a weird year. The best performing stocks of the year were GameStop (GME) and AMC Theaters (AMC), two companies that should probably be bankrupt. Another top performer was Lucid Motors, (LCID) a company that didn’t even have any sales for the year! To be fair, Lucid did start delivering cars in 4th quarter and should have some sales to start 2022.

But still, those are the sort of companies that you had to buy to beat the market. Very strange and hard to do – especially with your hard-earned nest egg.

The Growth Strategy held up very well until the 4th quarter of 2021 when many momentum names started to fail, and we stopped out of several (mostly for gains overall). In fact, there was a stretch from mid-May to mid-September where the Growth Strategy nearly doubled the return of the index.

End of the day, I am disappointed with the performance of the Growth Strategy for 2021. But long-term investors are still matching the upside of the market with less exposure to the downside. As I have always said, we will have bad months, bad quarters, and even bad years. But our focus is on managing risk, and long-term performance. I am confident that the methods we use to manage the Growth Strategy will continue to serve us well in the long run, even though 2021 was disappointing.

At the same time, I am very pleased with the performance of the Value Strategy which captured even more than half the upside of the index in 2021, while still achieving its downside protection goals.

Ultimately, this is a flip-flop from last year where the Value Strategy came up a little short and the Growth Strategy beat the index by a lot.

Outlook

I personally expect a major downside event in 2022. Maybe even in the first quarter. Maybe we are even seeing it start to happen already. As of this writing, the S&P 500 was down 5.10% since January 4th – that is more than we dropped from the highs ALL YEAR in 2021.

But that doesn’t mean the market won’t finish the year higher. As I pointed out earlier, the market has dropped 14% on average during each year since 1980 and has still managed to post a positive annual return 76% of the time.

Big drawdowns are where we do our best work. Remember, even our Growth Strategy isn’t designed to beat the market on the upside. We depend on the downside events to generate our long-term outperformance.

And as I also mentioned before, bonds don’t pay enough interest to get anyone’s attention. So, stocks are the place to be. The only question is: Which stocks?

We have a framework for that. That framework depends on what is happening with GDP, Inflation and Policy. What is happening with GDP and Inflation dictates policy from the government, in this case the FED. Depending on whether inflation is rising or falling, and whether GDP is rising or falling, the FED’s monetary policy tends to be predictable. For example, when both Inflation and GDP are rising, the FED has historically been hawkish (likely to tighten money supply by raising interest rates). And when both Inflation and GDP are falling, the FED has historically been dovish (likely to loosen money supply by lowering interest rates).

We can back test which sectors of the market tend to do best (and worst) based on those environments and then tailor our investment selections accordingly.

Today, even though the FED is taking hawkish, I see a shift toward very high Inflation starting to decline on a rate of change basis. Rate of change meaning that inflation can still be high, but as long as it is declining from something higher the rate of change is down. And GDP can keep rising on a rate of change basis. This situation usually leads to a neutral FED policy and is the best combination of the three factors for the economy.

To reiterate, inflation slowing, GDP rising, and FED policy neutral is often referred to as the Goldilocks Environment. I know it doesn’t sound like it, but the FED may just be “talking” rates higher. If the market reacts enough to their talking, they wont need to take aggressive action.

That doesn’t mean the market will go straight up any more than it means the market will go straight down. Heck, the market could even go nowhere for a whole year like it did in 2011. The phase changes typically lead to volatility before an ultimate direction is determined. Which means we might get a big drop in markets as participants position for the FED to raise interest rates. But by the time the FED gets around to doing so, there may be no need – and when market participants find out that the FED wont act so aggressively, they may go crazy buying stocks pushing the market even higher than where it finished 2021.

To be clear, “predictions” are something we do for fun around here. That is not how we manage money. We follow strict rules and react to the market we are in, not the market we hope for. And doing so has served us well over the long term.

We also know which stocks tend to do the best in these environments, and after stopping out of some positions in the Growth Strategy and holding a little extra cash in the Value Strategy – we know where to go looking for new positions.

Until next time. I thank God for each of you, and I thank each of you for reading this letter!

Happy New Year!

Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisor

Legal Information and Disclosures
This commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Elevate Capital Advisors, LLC (“Elevate”) has no duty or obligation to update the information contained herein. This information is being made available for educational purposes only. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elevate believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elevate. Further, wherever there exists the potential for profit there is also the risk of loss.